The growth in the cybersecurity market many pundits had expected last year didn't materialize, but 2017 is a different story entirely. Providers including Fortinet (FTNT 0.23%), Palo Alto Networks (PANW 0.91%), and a host of others are enjoying a banner year.
Fortinet stock is up 28% in 2017, and even Palo Alto, which hasn't seen a profit seemingly forever, is up 21%. The strong results aren't surprising given the rise in data breaches of late, including the recent crack in Equifax's (EFX -1.26%) security. But in Fortinet's case, the reason it could be a gold mine for growth investors is that it's not only in the right market, it's delivering the goods.
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More of the same, please
When Fortinet reports third-quarter earnings on Oct. 26, don't be surprised to see another strong period on both the top and bottom lines -- assuming last quarter, and several before that, are any indication Fortinet should keep the ball rolling.
Last quarter's $363.5 million in total revenue was a better-than-expected 17% jump compared to a year ago, and CEO Ken Xie's emphasis on service sales and the recurring revenue it generates should help his other goal of maintaining a handle on expenses.
Both product and service revenue climbed last quarter, but it was the latter that really shined. Product sales rose 4% to $142.7 million, which is a sound result given Fortinet's growth lies more with its service unit. The strong top line was largely due to the 26% increase in service revenue to $220.8 million, which now represents 61% of Fortinet's total, a percentage that's growing with each successive quarter.
Fortinet's earnings per share (EPS) is one thing that separates it from many of its peers, including Palo Alto. The $509.1 million in revenue Palo Alto reported last quarter was a 27% improvement over 2016. The difference between Fortinet and Palo Alto is that Palo Alto's impressive revenue growth doesn't trickle down due to its sky-high spending.
Another step in the right direction
Despite Palo Alto's revenue growth, its EPS sank 20% to a negative $0.42 compared to 2016's loss of $0.35 a share. Fortinet, on the other hand, translated its strong top line into a significant rise in per-share earnings. A year ago, Fortinet was in Palo Alto's shoes: no profits to show for its stellar revenue growth.
This year is entirely different with EPS soaring to $0.13 a share, demolishing last year's $0.01 a share loss. A big part of the reason Fortinet turned its revenue into profits was that operating expenses inched up a mere 3.6% to $239.32 million, more than acceptable considering its stellar 17% jump in revenue.
An area to improve upon is shaving sales-related costs. As it stands, Fortinet's sales costs of $166.34 million equal 46% of revenue. Though, to Fortinet's credit, relying more on ongoing service revenue minimized its rise in sales and marketing costs to just 2% year over year.
Last but not least
Some growth investors may cringe at Fortinet's valuation of 105.7 times earnings, but there's no need. Fortinet's peer's average price-to-earnings ratio (P/E) is a mind-boggling 116.9. Better still, looking ahead Fortinet is valued at a rock-bottom 33.9 times future earnings.
Though not all investors are enamored with share buybacks, Fortinet upped its existing program $300 million to $600 million in total, of which $456 million remains to repurchase additional shares between now and the end of Jan. 2018.
A year ago I was more bearish than bullish thanks to Fortinet's money-losing results. However, Xie's renewed expense management efforts and service revenue focus were clearly more than the "CEO-speak" investors often hear when financial performance isn't living up to expectations. But Fortinet is delivering, which is why it could be a gold mine for growth investors.
